German cities are ‘absolutely overpriced’ - report

German cities are becoming too expensive for many investors, in a sign that they are not prepared to pay absolutely any price for prime assets, according to PwC’s ‘Emerging Trends in Real Estate Europe 2019’ report, published this month.

The annual report, published jointly by the Urban Land Institute(ULI) and PwC, surveyed over 800 real estate professionals in Europe, including investors, developers, lenders, and advisors.

‘Berlin, Hamburg, Frankfurt and Munich are all great cities but at the moment they are absolutely overpriced,’ said one pan-European fund manager interviewed for the report. ‘It is almost impossible for us to find interesting opportunities.’

Still, despite being viewed as increasingly pricey, German cities have not completely lost their mojo. In the report’s overall rankings, Berlin comes in at number two, behind Lisbon, with three other German cities making the top ten: Frankfurt (5), Hamburg (7) and Munich (10).

Many of those surveyed expect Brexit to benefit Frankfurt, although the scale of any shift away from London has been hotly debated. Nonetheless, the presence of the ECB, good transport links and the ‘relatively low of living, compared with London and Paris’ makes Frankfurt attractive, according to the report.

Munich has dropped six places to number 10 this year, reflecting widespread concerns that it is increasingly overpriced: ‘It has always had tight cap rates, particularly for offices, but the demand side and rental growth side today support that relative to other markets,’ said another investor who contributed to the report. ‘It is attractive if you can find the right assets.’

Ultimately, the hunt for secure long-term income is driving European real estate investment as the industry hedges against potential interest rate rises and an uncertain geopolitical backdrop, according to the report.

‘Investors are becoming more cautious and investment and development preferences are more and more driven by real estate fundamentals such as economic growth prospects and health of the local occupier markets,’ said Lisette van Doorn, CEO of ULI Europe. ‘Sentiment is more negative on cities and countries facing higher (geo) political risks, which creates uncertainty that investors don’t like. Brexit is a clear example in this respect, where a number of respondents feel the UK will lose some of its competitive advantage, which impacts investment and development prospects.’

This is also reflected in people’s expectations regarding the availability of equity and debt, with around 28% of survey respondents believing that the amount of equity available for refinancing or new investment will increase, compared with 50% last year. However, last year’s confidence was particularly high, and there are few current concerns about liquidity, other than for struggling sectors such as retail.

One of the main barriers to investment continues to be the lack of availability of suitable assets as capital continues to flow into Europe, with strong increases expected from Asia. This is putting pressure on the core end of the market with 70% of survey respondents either agreeing or strongly agreeing that prime assets are overpriced.

Alternative assets gaining ground

As a result, alternative assets are becoming increasingly popular, in part because they are experiencing structural tailwinds but also because they are being less affected in the current cycle. ‘The last five or so years has seen a remarkable shift by investors towards alternative real estate, or “niche” sectors,’ said Gareth Lewis, head of real estate research at PwC UK. ‘In part, this is clearly driven by where we are in the cycle and the search for income. But it is also a response to the innovation that is disrupting the more traditional sectors and a number of long term trends such as demographics and urbanisation.’

Residential is leading the charge, accounting for seven out of the Top Ten preferred sub-categories regarding both investment and development, including co-living, student housing and retirement, according to the report.

‘Investors are seeking greater exposure to sectors that are supported by strong, more predictable demographic and infrastructure drivers, such as residential related sectors - and this requires them to focus more on the operational management of the assets,’ Lewis said.

In addition, logistics and niche sectors - including data centres and flexible offices – also make the Top Ten. Predictably, logistics continues to benefit from the surge in e-commerce, whereas traditional formats, such as city central or suburban offices and retailers, continue to languish at the bottom of the rankings, according to the report.

Cycle ‘close to peak’

Overall,two-thirds of Europe’s major cities offer ‘generally good’ investmentand development prospects going into 2019, according to respondents, withthe remainder in thebroadly ‘fair’ range. Nonetheless, many of Europe’s 31 major real estate markets are at an ‘advanced stage’, ‘close to the peak’ or ‘overpriced’, respondents said.

‘It is a good healthy market, but everyone is scratching their head asking: “How late in the cycle is it?”,’ mused one global investor. And although many of those surveyed maintain that ‘there isn’t necessarily a correction around the corner’, they are not allowing themselves to get carried away. ‘We are trying to be more cautious about how we set ourselves up for the next part of the cycle, reflecting on that with respect to which markets we invest in, which property types we invest in and the quality of the underlying real estate we are trying to create,’ said one fund manager.

Social value of real estate on the up

The social value of real estate is also gaining ground, according to the report. As a result, almost 60% of survey respondents maintain that the industry is moving towards using a wider range of non-financial measures to assess the value of real estate and real estate businesses. Similarly, 59% agree that non-financial metrics are increasingly important in measuring returns. This means that there is an increased focus on combining co-working spaces, retail and last-mile logistics with non-commercial uses, such as affordable housing, community centres and childcare facilities.

‘Our survey shows that the ability to balance societal and financial gains will be the next big differentiator for industry players, with investors favouring those that can demonstrate this through all their processes,’ said van Doorn.

In popular cities such as Berlin, rents have rocketed by 39% since 2011, according to a study of 160 German cities and student rents between 2011 and 2018, published earlier this year by German housing portals wg-suche.de and ImmobilienScout24.

Rentsin Berlin typically cost around €363 per month for a room in a shared house (WG) or €438 for a 30 sqm apartment, a price hike of 6% y-o-y, according to the study. Students in WGs or single apartments face the heftiest rent in cities such as Munich, Stuttgart, Frankfurt and Hamburg. A student looking for a single apartment or large room in a shared house of at least 25 sqm in Munich, which is also close to the university, will need to shell out around €785 a month, including utilities, for an apartment or €616 for a room in a shared house, an increase of 6% y-o-y and up 35% since 2011. By comparison, Dortmund is a bargain at €340 for an apartment, or €269 for a room in a shared house.

Stuttgart is the second most expensive city for students, with WG rooms costing €485 per month on average, compared to €438 in Freiburg, €425 in Ingolstadt, €410 in Hamburg and €388 in Cologne.

The majority of students – 40% - plump for a WG in Germany, to keep the costs down. An additional 28% either live at home or with a partner, 23% live in a single apartment and 9% live in student apartment blocks.

But as the market matures, so does the accommodation on offer. While 18,000 beds are currently in the pipeline to be delivered by the end of 2023, they are not all likely to be a pure student housing play, Beyerle said. ‘My gut feeling is that around 2,000 to 3,000 of these will be hybrid living, where you mix student accommodation with rentals for young professionals, for example.’

In a sense, this is the natural next step in an environment where co-living has become the latest resi buzzword. Business apartments have become increasingly popular due to micro apartment provider iLive Holding and serviced apartment group SMARTments, according to Catella.

Nonetheless, escalating rents aren’t sustainable in the long-run, Beyerle warned. ‘Rents will have to start to bottom out because they are way above the Mietspiegel in some cities and student housing is becoming a separate entity to the regular residential market.’ But for the record numbers of students going to university in Germany, even the notion of affordable rents must seem like something of a pipe dream. (ssk)